If you inherit someone else’s IRA you have to be really careful about mandatory distributions. Depending on your relationship to the person who passed away and their age, you may be required to take money out of the IRA every year no matter how young you are now. And if you fail to comply with those rules, the IRS could smack you with a 50% penalty.
Let’s make sure that doesn’t happen to you. First we’ll look at what happens when a spouse inherits an IRA and then we’ll consider what happens to a non-spouse when they get the money.
What Happens If You Inherit Your Spouse’s IRA?
If your spouse dies and you are the beneficiary, you can roll that money over to your own IRA. It’s a fairly popular option. If you do, all you have to do is take your own RMD when you reach 70 ½ and that’s it. It’s very simple and very easy and (in most cases) very beneficial to do this.
As an alternative, you can turn this into a “Beneficiary IRA”. There are special rules when a spouse elects to take the money as a Beneficiary IRA so you want to be careful. To be fair, there are a few (though not many) benefits to doing this especially if you could use some of that money before reaching age 59 ½.
Keep in mind that anyone who has an Inherited IRA can take money from the account before reaching age 59 ½ without paying a 10% penalty. If you keep the money in a spousal IRA Rollover, you don’t have that luxury. So, if you might want some of that money before reaching age 59 1/2, you could benefit by turning it into an Inherited IRA. And by the way, the cool thing is, a spouse is allowed to change their mind. That means that you could take the IRA as an Inherited IRA at first and later turn it into a spousal rollover. Joy!
Having said that, most tax pros suggest that people take advantage of the spousal rollover rules. Here’s why;
If this money becomes a spousal IRA rollover, the RMDs are calculated based on the survivor’s age – not the spouse’s. That means if you are younger than your deceased spouse, you only have to take RMDs when YOU reach age 70 ½ and your RMD amount is based on YOUR age. This is helpful if you want to keep your taxes low and you don’t need the money.
Non-Spouse Inherited IRA
If you inherit an IRA from someone you weren’t married to, your RMD schedule is very different. First, if the person who died was already taking distributions but died before taking the RMD for that year, you’ll have to take the money out that they would have as an RMD.
If they already took their RMD for the year or the person wasn’t required to take an RMD the year they died, you won’t have to withdraw anything that year. But you will have to start taking your RMD based on your age and a few other factors starting the year after the owner passed away.
The only way to avoid these annual distribution requirements is if you elect to take all the money out over 5 years. If you decide to do that, it doesn’t matter how much you take out in any one year. You could take out nothing for 4 years and take everything out in the 5th year.
If you inherit an IRA that probably means someone who cared a lot about you passed away. That it turn means you might be fairly shaken up and distracted. You might not be in the mood to deal with the ins and outs of these kinds of decisions. On top of the details of Spousal and Inherited IRAs, there are the issues of selecting the right beneficiary and titling the account correctly. These items might seem minor right now but one little mistake in these areas could be the difference between night and day for your family.
For this reason, I highly recommend that you speak with a qualified CPA and attorney before doing anything. The people at the bank or brokerage house might want to rush you into signing off so they can open a new account and keep control of the money. Don’t fall for it. Take your time before you do anything and get expert legal and tax advice. This is absolutely a time when spending that extra money on good council is highly worth it.